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Accounting Rate of Return (ARR) Calculator

Average annual profit as a percentage of investment.

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ARR

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Overview

The Accounting Rate of Return (ARR) is a capital budgeting metric used to evaluate the profitability of an investment project based on expected accounting profit. Unlike other methods, it uses net income figures from the income statement rather than cash flows to determine the percentage return on the capital cost.

Symbols

Variables

ARR = ARR, AAP = Avg Annual Profit, INV = Initial Investment

ARR
ARR
%
AAP
Avg Annual Profit
£
INV
Initial Investment
£

Apply it well

When To Use

When to use: ARR is typically used during the initial screening of capital projects to quickly compare the accounting profitability of various assets. It is most appropriate when managers want to see how an investment will affect future financial statements and reported earnings per share.

Why it matters: This metric is significant because it aligns with standard accounting practices, making it easier for stakeholders to understand project performance in the context of a company's financial reports. It provides a simple percentage that allows for quick comparisons across different industries or project types without complex cash flow forecasting.

Avoid these traps

Common Mistakes

  • Forgetting to deduct initial cost from total inflows to find total profit.
  • Using total profit instead of average annual profit.

One free problem

Practice Problem

A logistics firm is considering purchasing a new fleet of delivery trucks for 150,000. These trucks are expected to generate an average annual profit of 22,500 over their useful life. Calculate the Accounting Rate of Return (ARR) for this investment.

Avg Annual Profit22500 £
Initial Investment150000 £

Solve for: ARR

Hint: Divide the annual profit by the total initial cost and multiply by 100 to get a percentage.

The full worked solution stays in the interactive walkthrough.

References

Sources

  1. Corporate Finance by Stephen A. Ross, Randolph W. Westerfield, Jeffrey F. Jaffe
  2. Wikipedia: Accounting rate of return
  3. Corporate Finance by Stephen A. Ross, Randolph W. Westerfield, and Jeffrey F. Jaffe
  4. Principles of Corporate Finance by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
  5. Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance (13th ed.). McGraw-Hill Education.
  6. AQA A-level Business by Hall, Jones, Raffo, Wall, and Whitfield